Vol 3 No 1		April 2000

Katt & Company is a fee-only life insurance advising firm. We work with clients throughout the U.S. - primarily by phone, mail, email and telecopy. Typically, we assist clients buying life insurance, those who need existing policies reviewed and managed, and in support of litigation. For references please contact us.

Alert

(Information about specific life insurance companies is obtained during our work with clients and as such is ad hoc and not based on a systematic analysis of all life insurance companies. Although we believe the information presented is accurate, it is possible that it doesnĖt apply to all such policies identified because of different ages, ratings or policy structures).

Connecticut General (policies now being administered by Lincoln National Life) sold a participating whole life policy called Choice, beginning in the mid-1980s. Many of the Choice policies were sold based on premium payment scheme that used internal-policy borrowing after the payment of four premiums. In 2000 Lincoln announced a reduction in their dividends, the extent of which caused Lincoln to "...recognize that this change... has presented many producers with difficult client situations." Difficult indeed if my review of a client's situation is indicative of what other Choice policies that have used massive borrowing face. A 1998 in-force illustration showed costs of $2,500 for another 10 years with projected death benefits at the insured's age 85 of $5,820,000. A 2000 in-force illustration showing the affect of the reduced dividends projected into the future shows costs of $21,580 increasing steadily to over $200,000, and even with these huge increases in costs the projected death benefit at age 85 is now $3,680,000. I calculate that the net present value difference in costs and benefits has nearly a $1,400,000 impact on this Choice policy. If the unbelievable increase in this policy's costs is similar for other Choice policies a real disaster awaits those policies that are terminated because of the cost burdens. Because of the massive policy loans that are an inherent part of premium payment schemes that rely on massive borrowing policy terminations will very likely result in large amounts of phantom taxable income. These Choice policies should be reviewed to work out the most appropriate rescue plan.

Tip

Be aware that your clients' Life insurance companies make policy management mistakes that if not caught could be expensive to your clients. Last year I reviewed a client's universal life insurance policy and determined that it was substantially overpriced. Because I was quite familiar with this particularly company the overpricing didn't make sense, so I inquired. By making the insurance company look closely at the problem I presented to them they discovered that after switching to a new software administrative system they were mistakenly charging this female insured male mortality rates that were about 30% higher. Had I not known how to test the policy's pricing, this mistake probably would not have been detected and the client would have continued to pay 30% too much for their life insurance.

Again last year while reviewing a client's second-to-die policy I noted that the pricing appeared to be very overpriced. Upon inquiry the insurance company tried to waive me off, but with some persistence the insurance company's research discovered that their illustration system was double-charging costs on rated survivorship policies by charging sub-standard costs within the joint life pricing and again on an individual insured basis. With red faces they corrected their error. A good deal more than just knowing the physical location of your clients' life insurance policies is needed to professionally manage these important assets.

Information

Viatical settlements are a financial scheme that became popular in the 1980s. They involve the sale of a life insurance policy by a terminally ill insured to an intermediary (viatical firm) that then sells the policy itself or an irrevocable interest in the death benefits to investors. More recently, viatical firms have begun purchasing life insurance policies from healthy insureds that don't believe they need the coverage anymore.

While the purchase of life insurance from terminally ill insureds needing monies to pay for medical treatments serves a public good, all other aspects of this death-futures business are so troubling that healthy insureds selling their life insurance policies and investing in viaticated policies should be avoided.

With respect to healthy insureds selling life insurance, the only way this can have a rational financial basis for sellers is if either the viatical firms are overpaying for their purchases or life insurance companies are not charging enough for their policies. Since both viatical firms and insurance companies are in business to make profits and they employ financial analysts and actuaries to calculate such things, the loser in these transactions will be the seller who is ignorant about life insurance pricing. For healthy insureds there will always be a better financial solution than selling a life insurance policy. Every experience I have had with persons interested in selling an insurance policy is to relieve themselves of having to pay the premiums for coverage that is no longer necessary. But, eliminating future premiums can be done many ways without selling a policy. For example, a very healthy 60-year-old male with a large participating whole life policy purchased when he was 50 has sold his business and no longer needs the coverage for estate liquidity. He can withdraw all non-guaranteed cash values (up to his cost basis) tax-free and distribute them his beneficiaries. He can then change the policy to paid-up status (substantially reducing the policy's face amount). No more premiums will ever be required and the policy will increase in value as non-guaranteed dividends are received. This paid-up policy's rate-of-return will resemble a bond fund that is entirely income tax-free. The financial value of this strategy will always be better than selling a policy to a viatical firm.

Regarding investing in viaticated policies sold by terminally ill insureds, a recent experience I had consulting with an Iowa widow is consistent with what has been reported on about such investments. Mrs. Smith was solicited by a local financial planner to invest in what was described as "A Sound Investment, A Humanitarian Gesture" offered by a Florida viatical settlement firm. The sales materials given to Mrs. Smith guaranteed her investment results, but a close and thorough reading of all the documents made it clear that they contained serious misrepresentations, non-disclosures and deceptions. Some examples:

1. Documents claimed a "total fixed return on investment of 128%." This statement is both deceptive and false. Deceptive because the total return promised is actually 28%. 128% is the amount of the investment plus the promised profit. It is also deceptive because it refers to the investment return without regard to how much time it takes to obtain it. That is, a total return of 28% produces an annual rate-of-return of 13%, 8.6%, 6.4% and 5% for two, three, four and five years respectively. And "the total fixed return on investment of 128%" is false because it hasn't turned out to be a fixed return at all since Mrs. Smith has had to supplement her original investment with additional investment amounts (premiums), which changes the total return.

2. Documents misrepresented the certainty of when the insured will pass away. Since how long the insured lives will dictate the value of this investment it is critical information. Because investors aren't able to do an independent evaluation of the insured's health status they must depend on the viatical firm honestly and accurately assessing an insured's life expectancy.

The inherent problem with viatical settlements is that the middleman, the viatical firm, has the technical expertise to understand the very complicated assessment of the insured's medical prognosis, the life insurance policy's financial structure and how these two things affect their (the viatical firm's) profitability, none of which is disclosed to soliciting agents or consumers. Being in such total control of financial information is nearly the equivalent of having a license to steal because viatical investors will always be at the viatical firm's mercy, which is why any astute investor should never even consider these death-futures.